Year-end tax reporting generally does not require a detailed listing
of each trade, as is required for securities traders. Note: if
you haven't been reporting each securities trade on your tax returns
and
if you think that leaving
a note "available upon request" will suffice, don't be surprised if
the IRS does request - via an audit of your tax return! Why
allow your tax return to have any additional audit risk exposure?
Part of "the game" should be to lower your profile and lower your
exposure as well as lower your taxes!

Regardless of the fact that most futures trading is exempt from
detailed transaction reporting, traders must keep the detailed records
in their files, as any well-run business would maintain its records.
If you are audited, these details will be used to substantiate the
volume of your daily activity in support of claiming "trader status"
on your tax return. Screen shots of your year-to-date
transactions, saved and backed-up to multiple CD-Rs, may be invaluable
during an IRS audit. Also save your monthly statements and if
available, your confirmations.

To find a futures symbol
take the root & the letter for the month & the last digit for year:

The E-mini is classified as an IRC
§1256 contact and therefore the net capital gain or
loss from your trading will be divided into 60%
long-term and 40% short-term regardless of your actual
holding period. Therefore, when you have a net gain from
trading the E-mini, 60% of the net gain will be taxed at
the more favorable long-term capital gain rates and only
40% at the short-term capital gain rates.

When trading the E-minis you do not account for the wash sale
rule. The wash sale rule basically states that if you
sell a security at a loss and buy replacement stock 30-days
before or 30- days after the sale of the same security,
you are denied a current tax deduction of that loss (the
tax benefit of that loss is deferred).
Since the IRS wants to tax
all of your gains, this wash sale rule does not apply to
gains but only applies to losses.

When trading the E-mini you may make an election
annually to carryback a current year loss to three years
prior to offset previously taxed gains from trading the
E-mini
or other
§1256 items.
By filing in this manner you may be able to receive a
refund of the prior year taxes paid on the
§1256 items. Any
current year
§1256 loss (in
excess of up to $3,000 annual limit)
that you do not carryback would be carried forward indefinitely until it
is use up against future capital gains + $3,000 per year
against other income.

Optionally a trader may
make an IRC §475 election changing the net capital
gain/loss to a net ordinary gain/loss. Ordinary
losses are fully deductible against most all other types
of income and can be carried back two years and/or
forward twenty years. But ordinary gains are
generally taxed at the highest applicable tax rates and
you need to forgo the beneficial 60% / 40% rule
mentioned above.

When trading the E-mini you generally do not need to provide the IRS a list of all
the individual trades if the broker provides the net
gain of loss to you in the
§1256 section of IRS
form 1099-B. The net
gain or loss from your trading is then reported on IRS form 6781 without the corresponding detail.

General taxation
of the SPX and SPY

SPX, DJX, NDX, and RUT options are Index Options.
They are European Style options, which means, among
other things, that their monthly “last trading day” is
different than those of ETFs. Index options expire on
the third Friday of the month, so their last trading day
is the third Thursday of the month.

SPY, DIA, QQQ, and IWM are ETFs (Exchange Traded
Funds) and are American Style options, and both the last
trading day and the investor’s expiration day for these
options are the same: the third Friday of
the month just like options on individual stocks.

NON-EQUITY, INDEX OPTIONSSPX, DJX, NDX, RUT,
VIX (CBOE)
European Style
Cash settlementCan exercise only on expiration day
Can enter or exit from position at any time prior to
expiration.
Usually have wider bid-ask spread
Last trading day – third Thursday of month (day
before expiration day)
Expiration day – third Friday of monthTax treatment – 60% long-term /
40% short-term

ETF OPTIONSSPY, DIA, QQQ, IWM (XXI)
American Style
Physically settled
Can exercise any day
Can enter or exit from position at any time prior to
expiration.
Usually have narrower bid-ask
Last trading day – third Friday of month
Expiration day – third Friday of month (same as last
trading day)
Also available are quarterlies and weekliesTax treatment – 100% short term (when held less than one
year)

§1256 Mark-to-Market treatment vs. the §475 Mark-to-Market
election

Regulated futures (subject to mark-to-market treatment
and traded on a qualified board or exchange), non-equity options and
dealer equity options receive different treatment than NYSE/NASD
stocks and CBOE/OCC options . These types of contracts are governed by
IRS Code §1256
and are treated partly as a long-term gain or loss (60% of the gain or
loss) and partly as a short-term gain or loss (40% of the gain or
loss), regardless of the actual length of your holding period.

In addition to the above mentioned "mark-to-market treatment"
which is mandatory for investors as well as traders - certain
qualified traders may choose to separately make an optional, additional mark-to-market
accounting
election under IRS Code
§475.

Normally the mandatory mark-to-market treatment results in your
capital losses being deductible against capital gains and being then
subject to a $3,000-per-year net capital loss limitation in any one
year to be applied against ordinary income. There is also a
limited carryback available of any losses in excess of the $3,000
limitation as computed under
IRS Code §1256.

Whereas an advantage of the mark-to-market accounting election
for commodity/futures traders is that they are no longer subject to
the capital loss limitation in any one year. A qualified trader
who makes the separately optional election generally
would not be restricted from deducting any loss from trading
IRS Code §1256 futures/commodities
and would therefore be able to write off the entire loss against
ordinary income and could also carry any excess remaining loss (NOL)
back to prior years. Furthermore, although any gains would be changed
from "capital" to "ordinary," they would not be considered
self-employment income and therefore would not be subject to
self-employment tax.

The (potentially substantial) downside of making the relatively
permanent
§475 mark-to-market accounting election is that
your gains will be taxed at the higher ordinary tax rates - rather
than seeing 60% of the gains taxed at the preferable (lower) long-term
capital gain rates nor being available for offset against capital loss
carryforwards.

Tax Summary of the
§475
election for Futures/Commodities/§1256Contracts:
forgo making the election and...§1256 contracts
have a nice long-term gain rate for 60% of gains if
§475 M2M is
not elected.
§1256 contracts are
limited for deductibility of any trading losses if
§475 M2M is
not elected.

make the election and...
§1256 contracts have
no long-term gain rate for 60% of
gains if
§475 M2M is elected.
§1256 contracts are
not limited for deductibility of
any trading losses if
§475 M2M is elected. Old Capital Loss Carryforwards may be trapped on Schedule D if
§475 M2M is elected.

What qualifies for this
treatment a/k/a §1256 contract treatment?

Commodity Futures

A commodity futures contract is a
standardized, exchange-traded contract for the sale or purchase of a
fixed amount of a commodity at a future date for a fixed price.

If the contract is a regulated futures contract, the rules described
earlier under Section 1256 Contracts Marked To Market apply
to it.

The termination or closing of a commodity futures contract generally
results in capital gain or loss unless the contract is a hedging
transaction or unless a separate
IRS Code §1256 mark-to-market election has been made.

Securities Futures Contracts

A
securities futures contract is a contract of sale for future delivery of
a single security or of a narrow-based security index.

Under IRS Code §1234B and gain or loss from the contract generally will
be treated in a manner similar to gain or loss from transactions in the
underlying security. This means gain or loss from the sale, exchange, or
termination of the contract will generally have the same character as
gain or loss from transactions in the property to which the contract
relates. For Investors any capital gain or loss on a sale,
exchange, or termination of a contract to sell property will be
considered short-term, regardless of how long you hold the contract.
For Traders and for Investors these contracts are not §1256
contracts. For Dealers they will be treated as §1256 contracts.
Rev. Proc. 2002-11 severely limits who may qualify as a dealer in
securities futures contracts.

Section 1256 contract options.
Gain or loss is recognized on the exercise of an option on a section
1256 contract. Section 1256 contracts are defined under
Section 1256 Contracts Marked to Market

Section 1256 contracts and straddles.
Use Form 6781 to report gains and losses from section 1256 contracts and
straddles before entering these amounts on Schedule D. Include a copy of
Form 6781 with your income tax return.

Section 1256
Contracts Marked to Market

If you
hold a section 1256 contract at the end of the tax year, you generally
must treat it as sold at its fair market value on the last business
day of the tax year.

Provides that amounts
that must be deposited to, or can be withdrawn from, your margin
account depend on daily market conditions (a system of marking to
market), and

Is traded on, or
subject to the rules of, a qualified board of exchange. A qualified
board of exchange is a domestic board of trade designated as a
contract market by the Commodity Futures Trading Commission, any board
of trade or exchange approved by the Secretary of the Treasury, or a
national securities exchange registered with the Securities and
Exchange Commission.

Foreign currency
contract.This is a contract that:

Requires delivery of a
foreign currency that has positions traded through regulated futures
contracts (or settlement of which depends on the value of that type of
foreign currency),

Is traded in the
interbank market, and

Is entered into at
arm's length at a price determined by reference to the price in the
interbank market.

Bank forward contracts
with maturity dates that are longer than the maturities ordinarily
available for regulated futures contracts are considered to meet the
definition of a foreign currency contract if the above three conditions
are satisfied.

Special rules apply to
certain foreign currency transactions. These transactions may result in
ordinary gain or loss treatment. For details, see Internal Revenue Code
section 988 and regulations sections 1.988-1(a)(7) and 1.988-3.

Nonequity option.This is any listed option (defined later) that is not
an equity option. Nonequity options include debt options,
commodity futures options, currency options, and broad-based stock index
options. A broad-based stock index is based upon the value of a group of
diversified stocks or securities (such as the Standard and Poor's 500
index). (see definition of narrow based
stock index options below)

Warrants based on a stock
index that are economically, substantially identical in all material
respects to options based on a stock index are treated as options based
on a stock index.

Cash-settled
options. Cash-settled options based on a stock
index and either traded on or subject to the rules of a qualified board
of exchange are nonequity options if the Securities and Exchange
Commission (SEC) determines that the stock index is broad based.

This rule does not apply
to options established before the SEC determines that the stock index is
broad based.

Listed option.
This is any option that is traded on, or subject to the rules of, a
qualified board or exchange (as discussed earlier under Regulated
futures contract). A listed option, however, does not include an
option that is a right to acquire stock from the issuer.

Dealer equity option.This is any listed option that, for an options dealer:

Is an equity option,

Is bought or granted by
that dealer in the normal course of the dealer's business activity of
dealing in options, and

Is listed on the
qualified board of exchange where that dealer is registered.

An options dealer
is any person registered with an appropriate national securities
exchange as a market maker or specialist in listed options.

Equity option.
This is any option:

To buy or sell stock,
or

That is valued directly
or indirectly by reference to any stock or narrow-based security
index.

Equity options include
options on a group of stocks only if the group is a narrow-based stock
index.

Dealer securities
futures contract. For any dealer in securities
futures contracts or options on those contracts, this is a securities
futures contract (or option on such a contract) that:

Is entered into by the
dealer (or, in the case of an option, is purchased or granted by the
dealer) in the normal course of the dealer's activity of dealing in
this type of contract (or option), and

Is traded on a
qualified board or exchange (as defined under Regulated futures
contract,
earlier.)

A securities futures
contract that is not a dealer securities futures contract is treated as
described later under Securities Futures Contracts.

Marked to Market
Rules

A
section 1256 contract that you hold at the end of the tax year will
generally be treated as sold at its fair market value on the last
business day of the tax year, and you must recognize any gain or
loss that results. That gain or loss is taken into account in figuring
your gain or loss when you later dispose of the contract, as shown in
the example under
60/40 rule, below.

Hedging exception.
The marked to market rules do not apply to hedging transactions. See
Hedging Transactions, later.

60/40 rule.Under the marked to market system, 60% of your capital
gain or loss will be treated as a long-term capital gain or loss, and
40% will be treated as a short-term capital gain or loss. This is
true regardless of how long you actually held the property.

Example.
On June 23, 2001, you bought a regulated futures contract for $50,000.
On December 31, 2001 (the last business day of your tax year), the fair
market value of the contract was $57,000. You recognized a $7,000 gain
on your 2001 tax return, treated as 60% long-term and 40% short-term
capital gain.

On February 2, 2002, you
sold the contract for $56,000. Because you recognized a $7,000 gain on
your 2001 return, you recognize a $1,000 loss ($57,000 - $56,000) on
your 2002 tax return, treated as 60% long-term and 40% short-term
capital loss.

Limited partners or
entrepreneurs. The 60/40 rule does not apply to
dealer equity options or dealer securities futures contracts that result
in capital gain or loss allocable to limited partners or limited
entrepreneurs (defined later under Hedging Transactions).
Instead, these gains or losses are treated as short term.

Terminations and
transfers. The marked to market rules also apply if your
obligation or rights under section 1256 contracts are terminated or
transferred during the tax year. In this case, use the fair market value
of each section 1256 contract at the time of termination or transfer to
determine the gain or loss. Terminations or transfers may result from
any offsetting, delivery, exercise, assignment, or lapse of your
obligation or rights under section 1256 contracts.

Loss carryback
election. An individual or partnership having a net
section 1256 contracts loss (defined later) for 2002 can elect under
§1212(c) to carry
this loss back 3 years, instead of carrying it over to the next year.
See How To Report,
later, for information about reporting this election on your
return.

The loss carried back to
any year under this election cannot be more than the net section 1256
contracts gain in that year. In addition, the amount of loss carried
back to an earlier tax year cannot increase or produce a net operating
loss for that year.

The loss is carried to the
earliest carryback year first, and any unabsorbed loss amount can then
be carried to each of the next 2 tax years. In each carryback year,
treat 60% of the carryback amount as a long-term capital loss and 40% as
a short-term capital loss from section 1256 contracts.

If only a portion of the
net section 1256 contracts loss is absorbed by carrying the loss back,
the unabsorbed portion can be carried forward, under the capital loss
carryover rules, to the year following the loss. (See Capital Losses
under Reporting Capital Gains and Losses, later.) Figure
your capital loss carryover as if, for the loss year, you had an
additional short-term capital gain of 40% of the amount of net section
1256 contracts loss absorbed in the carryback years and an additional
long-term capital gain of 60% of the absorbed loss. In the carryover
year, treat any capital loss carryover from losses on section 1256
contracts as if it were a loss from section 1256 contracts for that
year.

Net section 1256
contracts loss. This loss is the lesser of:

The net capital loss
for your tax year determined by taking into account only the gains and
losses from section 1256 contracts, or

The capital loss
carryover to the next tax year determined without this election.

Net section 1256
contracts gain. This gain is the lesser of:

The capital gain net
income for the carryback year determined by taking into account only
gains and losses from section 1256 contracts, or

The capital gain net
income for that year.

Figure your net section
1256 contracts gain for any carryback year without regard to the net
section 1256 contracts loss for the loss year or any later tax year.

Traders in section 1256
contracts.Gain or loss from the
trading of section 1256 contracts is capital gain or loss subject to the
marked to market rules. However, this does not apply to contracts
held for purposes of hedging property if any loss from the property
would be an ordinary loss.

Treatment of
underlying property. The determination of whether
an individual's gain or loss from any property is ordinary or capital
gain or loss is made without regard to the fact that the individual is
actively engaged in dealing in or trading section 1256 contracts related
to that property.

How To Report

If you
disposed of regulated futures or foreign currency contracts in 2003 (or
had unrealized profit or loss on these contracts that were open at
the end of 2002 or 2003), you should receive Form 1099-B, or an
equivalent statement, from your broker.

Form 6781.Use Part I of Form 6781, Gains and Losses From
Section 1256 Contracts and Straddles, to report your gains and
losses from all section 1256 contracts that are open at the end
of the year or that were closed out during the year. This includes the
amount shown in box 9 of Form 1099-B. Then enter the net amount of these
gains and losses on Schedule D (Form 1040). Include a copy of Form 6781
with your income tax return. Note: If optional
§475 mark-to-market
was elected, then use Form 4797 rather than Schedule D.

If the Form 1099-B you
receive includes a straddle or hedging transaction, defined later, it
may be necessary to show certain adjustments on Form 6781. Follow the
Form 6781 instructions for completing Part I.

Loss carryback
election. To carry back your loss under the election
procedures described earlier, file Form 1040X or Form 1045,
Application for Tentative Refund,
for the year to which you are carrying the loss with an amended Form
6781 attached. Follow the instructions for completing Form 6781 for the
loss year to make this election.

Hedging
Transactions

The
marked to market rules, described earlier, do not apply to hedging
transactions. A transaction is a hedging transaction if both of
the following conditions are met.

You entered into the
transaction in the normal course of your trade or business primarily
to manage the risk of:

Price changes or
currency fluctuations on ordinary property you hold (or will hold),
or

Interest rate or
price changes, or currency fluctuations, on your current or future
borrowings or ordinary obligations.

You clearly identified
the transaction as being a hedging transaction before the close of the
day on which you entered into it.

This hedging transaction
exception does not apply to transactions entered into by or for any
syndicate. A
syndicate is a partnership, S corporation, or other
entity (other than a regular corporation) that allocates more than 35%
of its losses to limited partners or limited entrepreneurs. A
limited entrepreneur is a person who has an interest in an
enterprise (but not as a limited partner) and who does not actively
participate in its management. However, an interest is not considered
held by a limited partner or entrepreneur if the interest holder
actively participates (or did so for at least 5 full years) in the
management of the entity, or is the spouse, child (including a legally
adopted child), grandchild, or parent of an individual who actively
participates in the management of the entity.

Hedging loss limit.
If you are a limited partner or entrepreneur in a syndicate, the amount
of a hedging loss you can claim is limited. A hedging loss is
the amount by which the allowable deductions in a tax year that resulted
from a hedging transaction (determined without regard to the limit) are
more than the income received or accrued during the tax year from this
transaction.

Any hedging loss that is
allocated to you for the tax year is limited to your taxable income for
that year from the trade or business in which the hedging transaction
occurred. Ignore any hedging transaction items in determining this
taxable income. If you have a hedging loss that is disallowed because of
this limit, you can carry it over to the next tax year as a deduction
resulting from a hedging transaction.

If the hedging transaction
relates to property other than stock or securities, the limit on hedging
losses applies if the limited partner or entrepreneur is an individual.

The limit on hedging
losses does not apply to any hedging loss to the extent that it is more
than all your unrecognized gains from hedging transactions at the end of
the tax year that are from the trade or business in which the hedging
transaction occurred. The term unrecognized gain has the same
meaning as defined under Straddles, later.

Sale of property used
in a hedge. Once you identify personal property as being
part of a hedging transaction, you must treat gain from its sale or
exchange as ordinary income, not capital gain.

Self-Employment
Income

Gains
and losses derived in the ordinary course of a commodity or option
dealer's trading in section 1256 contracts and property related to these
contracts are included in net earnings from self-employment. In
addition, the rules relating to contributions to self-employment
retirement plans apply.

Joint Order Excluding Indexes Comprised of Certain Index Options from
the Definition of Narrow-Based Security Index pursuant to Section
1a(25)(B)(vi) of the Commodity Exchange Act and Section 3(a)(55)(C)(vi)
of the Securities Exchange Act of 1934

SUMMARY: The Commodity Futures Trading Commission ("CFTC") and
the Securities and Exchange Commission ("SEC") (collectively,
"Commissions") by joint order under the Commodity Exchange Act ("CEA")
and the Securities Exchange Act of 1934 ("Exchange Act") are excluding
certain security indexes from the definition of "narrow-based security
index." Specifically, the Commissions are excluding from the definition
of the term "narrow-based security index" certain indexes comprised of
series of options on broad-based security indexes.

Futures contracts on single securities and on narrow-based security
indexes (collectively, "security futures") are jointly regulated by the
CFTC and the SEC.1To
distinguish between security futures on narrow-based security indexes,
which are jointly regulated by the Commissions, and futures contracts on
broad-based security indexes, which are under the exclusive jurisdiction
of the CFTC, the CEA and the Exchange Act each includes an objective
definition of the term "narrow-based security index." A futures contract
on an index that meets the definition of a narrow-based security index
is a security future. A futures contract on an index that does not meet
the definition of a narrow-based security index is a futures contract on
a broad-based security index.2

Section 1a(25) of the CEA3
and Section 3(a)(55)(B) of the Exchange Act4
provide that an index is a "narrow-based security index" if, among other
things, it meets one of the following four criteria:

(i) the index has nine or fewer component securities;

(ii) any component security of the index comprises more
than 30 percent of the index's weighting;

(iii) the five highest weighted component securities of
the index in the aggregate comprise more than 60 percent of the
index's weighting; or

(iv) the lowest weighted component securities comprising,
in the aggregate, 25 percent of the index's weighting have an aggregate
dollar value of average daily trading volume of less than $50,000,000
(or in the case of an index with 15 or more component securities,
$30,000,000), except that if there are two or more securities with equal
weighting that could be included in the calculation of the lowest
weighted component securities comprising, in the aggregate, 25 percent
of the index's weighting, such securities shall be ranked from lowest to
highest dollar value of average daily trading volume and shall be
included in the calculation based on their ranking starting with the
lowest ranked security.

The first three criteria evaluate the composition and weighting of
the securities in the index. The fourth criterion evaluates the
liquidity of an index's component securities.

Section 1a(25)(B)(vi) of the CEA and Section 3(a)(55)(C)(vi) of the
Exchange Act provide that, notwithstanding the initial criteria, an
index is not a narrow-based security index if a contract of sale for
future delivery on the index is traded on or subject to the rules of a
board of trade and meets such requirements as are jointly established by
rule, regulation, or order by the Commissions. Pursuant to that
authority, the Commissions may jointly exclude an index from the
definition of the term narrow-based security index.5

In September 2003, CBOE Futures Exchange, LLC ("CFE"), a designated
contract market approved by the CFTC, announced plans to trade futures
contracts on certain "volatility indexes" created by the Chicago Board
Options Exchange, Inc. ("CBOE").6
Each of these volatility indexes is designed to measure the variability
of daily returns on a security index ("Underlying Broad-Based Security
Index"), as reflected in the prices of options on the Underlying
Broad-Based Security Index. Accordingly, the component securities of a
volatility index are put and call options on a security index.7
In light of CFE's announcement, the Commissions have considered whether
volatility indexes are narrow-based security indexes.

II. DISCUSSION

The statutory definition of the term narrow-based security index is
designed to distinguish among indexes comprised of individual stocks. As
a result, certain aspects of that definition are designed to take into
account the trading patterns of individual stocks rather than those of
other types of exchange-traded securities, such as options. However, the
Commissions believe that the definition is not limited to indexes on
individual stocks. In fact, Section 1a(25)(B)(vi) of the CEA and Section
3(a)(55)(C)(vi) of the Exchange Act give the Commissions joint authority
to make determinations with respect to security indexes that do not meet
the specific statutory criteria without regard to the types of
securities that comprise the index.

Subject to the conditions set forth below, the Commissions believe
that it is appropriate to exclude certain indexes comprised of options
on broad-based security indexes from the definition of the term
narrow-based security index. An index must satisfy all of the following
conditions to qualify for the exclusion.

The first condition limits the exclusion to indexes that measure
changes in the level of an Underlying Broad-Based Security Index over a
period of time using the standard deviation or variance of price changes
in options on the Underlying Broad-Based Security Index. The Commissions
believe this condition is necessary to limit the exclusion to indexes
calculated using one of two commonly recognized statistical measurements
that show the degree to which an individual value tends to vary from an
average value. The second, third, and fourth conditions provide that the
exclusion applies to indexes that qualify as broad-based security
indexes under the statutory criteria that evaluate the composition and
weighting of the securities comprising an index. The fifth condition
provides that the exclusion applies only if the Underlying Broad-Based
Security Index qualifies as a broad-based security index under the
statutory criterion that evaluates the liquidity of the securities
comprising an index. The Commissions believe at this time that this
condition is appropriate so that any such Underlying Broad-Based
Security Index, including those that are not narrow-based under any of
the exclusions to the definition under Sections 1(a)(25)(B) of the CEA
and 3(a)(55)(C) of the Exchange Act, meets the statutory liquidity
criterion. The sixth condition provides that the exclusion applies if
the options comprising the index are listed and traded on a national
securities exchange. Given the novelty of volatility indexes, the
Commissions believe at this time that it is appropriate to limit the
component securities to those index options that are listed for trading
on a national securities exchange where the Commissions know pricing
information is current, accurate and publicly available. Finally, the
seventh condition provides that the exclusion applies only if the
options comprising the index have an aggregate average daily trading
volume of 10,000 contracts. The Commissions believe that this condition
limits the exclusion to indexes for which there is a liquid market on a
national securities exchange for the options on the Underlying
Broad-Based Security Index, which contributes to the Commissions' view
that futures on such indexes should not be readily susceptible to
manipulation.

The Commissions believe that indexes satisfying these conditions are
appropriately classified as broad based because they measure the
magnitude of changes in the level of an underlying index that is a
broad-based security index. In addition, the Commissions believe that
futures contracts on indexes that satisfy the conditions of this
exclusion should not be readily susceptible to manipulation because of
the composition, weighting, and liquidity of the securities in the
Underlying Broad-Based Security Index and the liquidity that the options
comprising the index must have to qualify for the exclusion.
Specifically, these factors should substantially reduce the ability to
manipulate the price of a future on an index satisfying the conditions
of the exclusion using the options comprising the index or the
securities comprising the Underlying Broad-Based Security Index.

Accordingly,

IT IS ORDERED, pursuant to Section 1a(25)(B)(vi) of the CEA and
Section 3(a)(55)(C)(vi) of the Exchange Act, that an index is not a
narrow-based security index, and is therefore a broad-based security
index, if:

(1) The index measures the magnitude of changes in the
level of an Underlying Broad-Based Security Index that is not a
narrow-based security index as that term is defined in Section 1(a)(25)
of the CEA and Section 3(a)(55) of the Exchange Act over a defined
period of time, which magnitude is calculated using the prices of
options on the Underlying Broad-Based Security Index and represents (a)
an annualized standard deviation of percent changes in the level of the
Underlying Broad-Based Security Index; (b) an annualized variance of
percent changes in the level of the Underlying Broad-Based Security
Index; or (c) on a non-annualized basis either the standard deviation or
the variance of percent changes in the level of the Underlying
Broad-Based Security Index;

(2) The index has more than nine component securities,
all of which are options on the Underlying Broad-Based Security Index;

(3) No component security of the index comprises more
than 30% of the index's weighting;

(4) The five highest weighted component securities of the
index in the aggregate do not comprise more than 60% of the index's
weighting;

(5) The average daily trading volume of the lowest
weighted component securities in the Underlying Broad-Based Security
Index upon which the index is calculated (those comprising, in the
aggregate, 25% of the Underlying Broad-Based Security Index's weighting)
has a dollar value of more than $50,000,000 (or $30,000,000 in the case
of a Underlying Broad-Based Security Index with 15 or more component
securities), except if there are two or more securities with equal
weighting that could be included in the calculation of the lowest
weighted component securities comprising, in the aggregate, 25% of the
Underlying Broad-Based Security Index's weighting, such securities shall
be ranked from lowest to highest dollar value of average daily trading
volume and shall be included in the calculation based on their ranking
starting with the lowest ranked security;

(6) Options on the Underlying Broad-Based Security Index
are listed and traded on a national securities exchange registered under
Section 6(a) of the Exchange Act; and

(7) The aggregate average daily trading volume in options
on the Underlying Broad-Based Security Index is at least 10,000
contracts calculated as of the preceding 6 full calendar months.

By the Commodity Futures Trading Commission.

Jean Webb
Secretary

March 25, 2004

By the Securities and Exchange Commission.

Margaret H. McFarland
Deputy Secretary

March 25, 2004

1See
Section 1a(31) of the CEA and Section 3(a)(55)(A) of the Exchange Act, 7
U.S.C. 1a(31) and 15 U.S.C. 78c(a)(55)(A).

5See, e.g.,
Joint Order Excluding from the Definition of Narrow-Based Security Index
those Security Indexes that Qualified for the Exclusion from that
Definition under Section 1a(25)(B)(v) of the Commodity Exchange Act and
Section 3(a)(55)(C)(v) of the Securities Exchange Act of 1934 (May
31, 2002), 67 FR 38941 (June 6, 2002).

6See CBOE
News Release, "CBOE Announces Launch of Futures on VIX: First Tradable
Volatility Product Will be Offered on New CBOE Futures Exchange"
(September 5, 2003). The news release is available at www.cboe.com.

7CBOE has
published a White Paper describing the calculation and methodology of
its volatility indexes, which is available at www.cboe.com/micro/vix/vixwhite.pdf.

http://www.sec.gov/rules/exorders/34-49469.htm

drsynthetic: I have an IRS letter that talks about those types of
trades, I asked for it last tax season.

drsynthetic: here is the IRS excerpt -There is a quirk in the tax law in
regard to exchange-traded options of index stocks (for example QQQ, SPX,
XOI, etc.). These are a type of nonequity option. Nonequity options are
all options that are not directly or indirectly related to a specific
equity (stock).

The IRS has issued a ruling that QQQs are a type of nonequity option.
Most if not all publicly traded index options are nonequity options and
are subject to the provisions of Internal Revenue Code Section 1256.
Nonequity options are usually reported on Form 6781, unless they are
used as a hedge.

A hedge would be buying, for example, the QQQ, and then selling call
options against them.

WolfK: After much back and forth, the IRS told me that it comes down to
whether the issuer of the option considers it an equity option. I asked
the AMEX about their options and never got an answer. You know anyone to
call over there?

The Mixed Straddle
Election

Any straddle made up of
non-§1256 contracts and at least one §1256 contract is a "mixed
straddle." 241 Such a straddle can have a number of tax consequences:

As indicated in the
discussion of the mark to market rule, where at year end the §1256
position is marked to market for a gain, this gain must be recognized
without taking into account any unrecognized losses from any
offsetting non- §1256 contract positions. Conversely, where the
marking to market of the §1256 contract results in a loss, it will be
disallowed under the §1092 loss deferral rule if there is any
unrecognized gain with respect to offsetting non-§1256 positions.

Without regulations
that require a different result, the mixed straddle can convert
short-term gain to 60/40 gain.

/Footnote/ 241
Technically, a "mixed straddle" does not come into being until its
positions have been identified. §1256(d)(4). For ease of reference,
however, the term is used in this discussion as defined above. Where the
§1256(d)(4) meaning is intended, this will be termed a "§1256(d) mixed
straddle."

Example—Mixed Straddles

A taxpayer holding a
mixed straddle has $100 of unrelated short-term capital gain. He closes
out the non-§1256 straddle position242 for a loss of $100.
This loss offsets the unrelated gain. The §1256 position is closed out
for a gain of $100, subject to 60/40 treatment. While the straddle
positions offset each other, the taxpayer winds up with the unrelated
short-term gain converted to 60/40 gain.

If, on the other hand, the §1256 position is the loss position, the
result is the opposite. Assume again that there is $100 of unrelated
gain. If the gain is long-term, disposition of both sides of the
straddle ($100 of short-term gain from the non §1256 position; $60 of
long-term loss and $40 of short- term loss from the §1256 position) will
leave the taxpayer with $60 of short-term gain and $40 of long- term
gain. Thus, $60 of the long-term gain has been converted to short-term
gain.

As explained below, regulations issued to implement the modified short
sale rules effectively prevent any tax benefit from a mixed straddle by
requiring characterization of any loss attributable to the non- §1256
position as 60/40 loss. There is no provision changing the
disadvantageous result, however, where the loss position is the §1256
position. This one-way anti-conversion rule is sometimes called the
"killer" rule.

/Footnote/ 242 In the
discussion below, "§1256 position" and "non-§1256 position" dispense
with the word "contract" after "§1256."

The adverse tax
consequences outlined above can be avoided, however, by making a mixed
straddle election243.

/Footnote/ 243 The
killer rule can also be avoided by making the elections provided by Regs.
§1.1092(b)-3T and 1.1092(b)-4T, explained below.

Where the taxpayer
identifies all the positions of such a straddle before the close of the
day (or such earlier time as provided by regulations) on which the first
§1256 contract included in the straddle is acquired, the taxpayer may
elect to have the mark to market and 60/40 rules not apply to all §1256
contracts in the straddle244. The mixed straddle election
applies on a straddle-by-straddle basis.

/Footnote/ 244
§1256(d). This election is sometimes referred to as the "§1256(d)
election." It is irrevocable unless the IRS consents. Technically, a
"mixed straddle" arises only where identification and election have
occurred, but the term is used here (and in the §1092(b) regulations) to
mean any straddle qualifying for such election regardless of whether it
has been so identified.

No action need be taken
to identify non-§1256 contract positions before the first §1256 contract
position of the straddle is acquired. Thus, an options dealer may have a
stock position acquired at an earlier date included in the mixed
straddle election. To include the previously acquired stock in the
election, the taxpayer must identify both the stock and the option
position as being the positions of the mixed straddle before the end of
the day on which he acquired the option.

A mixed straddle may
also be identified as an "identified straddle245." In this
case, not only do the mark to market and 60/40 rules not apply to any
of the §1256 contracts in the straddle, but the loss deferral rules
do not apply to any positions in the straddle or to any other positions
held by the taxpayer by reason of their being offsetting to positions
that are part of the identified straddle.

/Footnote/ 245
§1092(a)(2).

Many taxpayers would be
presented with a difficult choice in choosing whether to make the
§1256(d) election, thus forfeiting any advantage from 60/40 treatment of
gains from §1256 contracts, or not to make the election, risking
the adverse tax consequences outlined above. As discussed below,
however, the §1092(b)(2) regulations offer an alternative to the
§1256(d) election that substantially preserves the advantage of 60/40
treatment of any net gain from a mixed straddle.

The §1092(b)
RegulationsIntroduction
As part of the loss deferral rules for straddles246, Congress
directed the IRS to prescribe "such regulations with respect to gain or
loss on positions which are part of a straddle" as are appropriate to
carry out the purposes of §1092. Congress provided that "to the extent
consistent with such purposes" the regulations were to include rules
applying wash sale principles247 and certain portions of the
short sale rules248 discussed above249.
/Footnote/ 246 §1092.
/Footnote/ 247 §1091(a) and §1091(b).
/Footnote/ 248 §1233(b) and §1233(d).
/Footnote/ 249 §1092(b)(1).

In enacting 1984 amendments to the loss deferral rules, Congress
understood that the straddle rules, including the regulatory extension
of wash and short sale principles to straddle transactions (as revised
to include stock options), would create difficulties for traders who
regularly enter into mixed straddles. This was especially so for options
dealers who typically grant, buy and sell dealer equity options (§1256
contracts) while holding non-§1256 contract long or short positions in
the underlying stock. To deal with this problem, Congress specified that
the §1092(b) regulations were to provide "elective provisions in lieu of
§1233(d) principles," namely, provisions permitting the taxpayer to
offset gains and losses from positions that are part of a mixed straddle
under rules requiring either straddle-by-straddle identification or the
creation of mixed straddle accounts250.
/Footnote/ 250 §1092(b)(2).

The (temporary) regulations issued under these directives fall into
three parts.
(1) The first part251 coordinates the wash sale rules with
the loss deferral rules and governs the extent to which a loss sustained
from the disposition of a straddle position must be deferred.
(2) The second part252 contains rules based on principles
similar to those underlying the short sale rules relating to the
treatment of holding periods and the characterization of losses
sustained with respect to straddle positions.
/Footnote/ 251 Temp. Regs. §1.1092(b)-1T.
/Footnote/ 252 Temp. Regs. §1.1092(b)-2T.

Note: Parts (1) and (2) parts are referred to as the "§1092(b)(1)
regulations."
(3) The third part provides rules carrying out the directive of
§1092(b)(2) to provide elective alternatives to the Regs. §1.1092(b)(1)
provisions applying §1233(d) principles. These regulations are called
the "§1092(b)(2) regulations."

WASHINGTON (HedgeWorld.com)
- The U.S. Senate's vote for the Jobs and Growth Tax Relief
Reconciliation Act of 2003 came with a last- minute kicker - a
manager's amendment containing various revenue enhancers including the
abolition of the current 60/40 tax treatment for gains and losses on
futures and options transactions.

The Futures Industry Association, Washington, opposes any such
change. Its president, John M. Damgard, said Tuesday that he is
very curious about the origins of the idea. "Somebody in the
bowels of the treasury has a drawer full of what they call revenue
enhancers' - what we call tax increases - and this one comes out
of the drawer regularly," he said. Furthermore, the "scoring"
(i.e. the calculation of the amount of revenue the amendment would
raise) is suspect. "Funny arithmetic sometimes is necessary to
make things work," he said.

In this case, it "worked" in the sense of securing passage but
just barely. Despite the revenue-enhancing amendments, proposed by
Sen. Chuck Grassley (R-Iowa) in order to firm up the commitment of
wavering senators worried about ballooning the deficit, the bill
carried only 51 to 50, with the tie-breaking vote of Vice
President Dick Cheney.

Mr. Grassley, chair of the Senate Finance Committee and floor
manager for the bill, proposed the amendments as part of a package
that included a two-year phase-in of an exemption of dividend
income from the federal income tax. The proposed dividend tax
relief, long a priority of the Bush administration, comes with a
sunset provision for 2007.

The resulting bill, passed by the Senate May 15, is in many
ways quite different from the version passed by the House of
Representatives on May 9. The House bill reduces but does not
eliminate tax rates on dividends and capital gains, and its
reduction (to 15%) does not expire until 2013. The House bill also
contains no change in the 60/40 rule. The conference committee
will have to hash all this out.

The 60/40 tax rule dates to 1981, when it was part of a
compromise to a dispute over whether taxpayers should be required
to mark their "butterfly straddles" to market value. Internal
Revenue Code 1256 was created to require taxpayers to characterize
the gains or losses on futures contracts as 60% long-term and 40%
short-term capital gains or losses, regardless of how long the
contracts had been held.

Since 1981, according to Garry L. Moody, national director of
Deloitte & Touche LLP's investment management services group,
hedge funds that trade in options have been able to account for
their short-term gains as offsets to expenses, while the 60%
accounted as long-term gain gets favorable tax treatment. "Taking
this away would have a favorable impact on the budget," Mr. Moody
acknowledged, but "I'm sure there's going to be a lot of
discussion before this is enacted."

Chicago Exchanges Both Opposed

On Monday, the leadership of the Chicago Mercantile Exchange
and the Chicago Board of Trade sent a joint letter for the
conferees, warning that abrogation of the 60/40 rule will "impair
liquidity in U.S. futures markets and thereby increase the cost of
government debt by reducing the ability of bidders in treasury
market auctions to hedge their exposures in fixed-income and
interest rate futures markets."

Separately, Charles P. Carey, chairman of the board of the CBOT,
and Bernard W. Dan, its chief executive, sent a letter to their
membership describing the Senate's action as a "grave danger" to
the industry. The letter added that both men (and CME Chairman
Terry Duffy) would be traveling to Washington this week as the
House/ Senate conference looms.

"Our D.C. office is fully engaged and coordinating with a
coalition of markets and market users to ensure that this proposed
legislation does not become law," members were assured.